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INDEX:

SR NO. 1

CHAPTER NAME

PAGE NO. 1

INTRODUCTION

EMPLOYEE COMPENSATION MANAGEMENT

FRINGE BENEFITS

EMPLOYEE STOCK OPTIONS AND PLANS

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INDIAN COMPANIES TO USE EMPLOYEE STOCK OPTIONS EMPLOYEE STOCK OPTIONS AS A TOOL FOR HRM

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EMPLOYEE STOCK OPTIONS AS A STRATEGIC TOOL

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CONCLUSION

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BIBLIOGRAPHY

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CHAPTER 1

INTRODUCTION

Organizations are run and steered by people. It is through people that goals are set and objectives realized. The performance of an organization is, thus, dependent upon the sum total of the performance of its members. According to Peter Drucker, an organization is like a tune. It is not constituted by individual sounds but by their synthesis. The success of an organization, therefore, depends on its ability to accurately measure the performance of its members and use it objectively to optimise them as vital resources.

The performance of the organisation is astutely linked to employee emotions such as ownership and loyalty. Without them, employees fail to effectively work in synchronisation with the goals and vision of the employees. A sense of employee ownership and loyalty is important if the organisation would like to achieve its goals. Organisations whose employees experience a heightened sense of ownership and loyalty are less likely to have absenteeism, lower rates of employee turnover and lesser chances of failure to meet goals.

One such way to ensure that employees feel a sense of ownership and responsibility is through employee stock options.

An Employee Stock Option Plan (ESOP) is a benefit plan for employees which makes them owners of stocks in the company. ESOPs have several features which make them unique compared to other employee benefit plans. Most companies, both at home and abroad, are utilising this scheme as an essential tool to reward and retain their employees. Currently, this form of restructuring is most prevalent in IT companies where manpower is the main asset.

The idea behind stock options is to align incentives between the employees and shareholders of a company. Shareholders want to see the stock appreciate, so rewarding employees when the stock goes up ensures, in theory, that everyone is striving for the same goals.

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CHAPTER 2

EMPLOYEE COMPENSATION MANAGEMENT Compensation refers to all forms of financial returns, tangible services and benefits employees receive in exchange for their contribution to the organization. It determines their standard of living, their attitude towards the company and influences their motivation to work. There has to be a fairness in compensating the workers according to the work done by them. It is an important aspect from the employer and the employees point of view and to strike a balance between them it is important to select the system of wage payment carefully.

Compensation payable to an employee includes 3 components:

1. Basic compensation for the job (wage/ salary) 2. Incentive compensation for the employee on job (dearness allowance, profit sharing, bonus) 3. Supplementary compensation paid to employees (fringe benefits and employee services).

Dearness allowance-

Dearness allowance is paid to employees in order to enable them to face the increasing rise in prices of essential commodities. In general, there are three methods of grating DA-

1. A uniform fixed rate of DA in accordance with each point of rise. 2. Flat rate of DA irrespective of wages to all the workers. 3. DA at rates varying according to income groups.

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BonusIn addition to the basic wage and dearness allowance, bonus also constitutes an important component of employees earnings in India. Bonus thus means payment as an incentive to regularity of attendance, or to encourage good work or a payment for some special or additional service rendered by labour.

OBJECTIVES OF COMPENSATION PLANNING-

Some of the important objectives that are sought to be achieved through effective compensation management are:

1. Attract talentCompensation needs to be high to attract talented people as firms compete to hire services of competent people and the salaries offered must be high enough to motivate them to apply.

2. Ensure equityPay should equal the worth of a job. Similar jobs should get similar pay. Likewise more qualified people should get better wages.

3. New and desired behaviorPay should reward loyalty, commitment, experience, risks taking, initiative and other desired behaviors. When company fails to reward such behaviors employees go in search of better avenues.

4. Control costsThe costs of hiring people should not be too high. Effective compensation management ensures that workers are neither overpaid nor underpaid.

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5. Ease of operationThe compensation management system should be easy to operate as to promote understanding regarding pay related matters between employees, unions and managers.

COMPONENTS OF AN EMPLOYEE PACKAGE

1. Wage / Salary : Wage is the payment as per the pay scale decided by the employer. Wage represents hourly-rate of pay while salary refers to the monthly rate of pay, irrespective of the number of hours put in by an employer. Salary includes dearness allowance and other approved ones and is paid on a specific day of each month as decided by the management. Salary payment is not uniform to all employees as it depends on the nature of the job, responsibilities assigned, merits available, status, seniority of the employee and so on. It is made attractive to all categories of workers. It constitutes major source of regular income to large majority of industrial and other categories of employees. Wages are now linked with Cost of living.

2. Incentives : Monetary incentives are offered as a supplement to wage payment. The basic purpose behind this is to encourage / motivate employees to take more interest/ initiative in the work, show concrete results and collect extra payment as per rules . Incentives are payment by results. Incentive payment is in addition to regular wage payment .Incentive depend on productivity, sales, profit , cost reduction efforts of employees and so on, Incentives includes Individual incentive and Group incentive.

3. Fringe benefits: These are monetary benefits provided to employees. They include the benefit of a) Provident Fund and Gratuity b) Medical Care and Hospitalisation c) Accident Relief, Health and Group insurance d) Subsidised Canteen facility, Recreation facilities

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4. Perquisites: There are special benefits offered to managers / executives. The purpose is to retain competent executives by offering them special benefits. Perquisites includes a) Company car for travelling b) Club membership c) Paid holidays d) Furnished house / accommodation e) Stock option schemes 5. Non Monetary benefits: They include comfortable working conditions, impartial promotions , support to workers facing special problems , provision of welfare facilities to employees and so on.

IMPORTANCE OF WAGE PAYMENT TO: 1. Employees- Wage payment is important to all categories of workers. Their life, welfare and social status depend on wage payment. Certain employees and their unions demand higher wages and monetary benefits and they include factory workers, bank employees, government servants and teachers.

2. Employer- Wage payment is equally important to employers as their profit depends on the total wage bill. An employer generally is interested in paying low wages and this not necessarily economical. An employer has a social responsibility to pay fair wages to his workers as they are equal partners in the production process. Infact it is possible to earn more profit by paying attractive wages to workers.

3. Government- Government gives special attention to wages paid to industrial workers as industrial development, industrial peace, productivity and cordial labour management relations depend on wage payment to workers. Government introduced the Minimum Wages Act in order to protect the working class. Government is the biggest employer in India and wage rates of employees of public sectors are decided by the Government itself for which Pay Commission is appointed and pay scales are adjusted as per recommendations. 5|Page

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CHAPTER 3

FRINGE BENEFITS

Fringe benefits and services include a motley crowd of fringes starting from accident compensation to paid holidays. Such benefits are always in addition to regular wage payment i.e. direct remuneration. They support regular wage payment. They are also known as fringes, service programmes, employee benefits or hidden payroll. Fringes embrace a broad range of benefits and services offered to employees. They constitute indirect compensation as they are extended as a condition of employment and not directly related to individual performance. The purpose of fringe benefits is to retain efficient/capable people in the organisation. They foster loyalty and act as security base for the employees.

Fringe benefits may be defined as broad/wide range of benefits and services that employees receive as an integral part of their total compensation package. Fringes embrace a broad range of benefits and services that employees receive as a part of their total compensation package. Such benefits include benefits such as provident fund, gratuity, medical care, hospitalisation, accident relief, health and group insurance, canteen, uniform, recreation and the like. Such benefits are based on critical job factors and performance. They constitute indirect compensation as they are usually extended as a condition of employment and not directly related to performance of concerned employee. Fringe benefits are supplements to regular wages received by workers. They also include benefits such as paid vacation, pension, health and insurance plans, etc. such benefits are computable in terms of money and the amount of benefit is generally not predetermined.

Fringe benefits constitute a substantial labour cost for any organisation and not mere fringe costs or fringe items. Such benefits are important and useful to managements, employee and the unions. The terms fringes and services are often used interchangeably as they both offer benefit to employees in one form or the other. Employee benefits and services are alternatively known as fringes or hidden payroll. Fringe benefits are also thought of as the costs of keeping employees other than salary.

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FEATURES OF FRINGE BENEFITS:

1. Different from regular wages: Fringe benefits are different from regular wages as such benefits are those payments which an employee enjoys in addition to wages he receives. It is a supplementary payment and provides support to an employee.

2. Useful but avoidable expenditure: Fringe benefits constitute a labour cost for the employer. It is a useful expenditure but also an avoidable one as compared to wages which must be paid regularly.

3. Not directly linked with efforts: Fringe benefits are not a direct reward for the efforts made or the production given by an employee. It is given on considerations such as length of service, sickness and the hazards of life which he encounters.

4. Beneficial to all employees: Fringe benefit is made available to the entire labour and not to a small group of employees. For example, subsidized canteen facility is a fringe benefit but subsidizing non-vegetarian thali need not be treated as a fringe benefit as it is available only to vegetarian employees.

WHY FRINGE BENEFITS ARE OFFERED?

1. To supplement direct remuneration: Fringe benefits supplement regular pay of employed. It raises the total earnings of an employee and provides better welfare to him. Employees prefer such indirect remuneration as regular salary income is taxable but such benefits are not taxable. Such benefits protect employees against certain hazards of life.

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2. Employees prefer fringe benefits: Employers prefer this indirect remuneration to direct pay increase. Such benefits can be offered economically and can be explained to the shareholders as the social responsibility of business. Moreover, such benefits give quick result in the form of employee satisfaction, increase in the efficiency and productivity of employees and high employee morale.

3. To retain competent employees: Fringe benefits create satisfied labour force. In addition, the management can attract and retain competent personnel in the organization by offering liberal packet of fringe benefits. For example, group insurance and medical facilities are useful to employees, holidays and leave travel concession, etc. remove fatigue of employees and raises their efficiency. In brief, Fringe benefits act as special attractions to employees. They prefer to remain stable over a long period in one organization due to such benefits offered.

4. To develop good corporate image: Fringe benefits help to develop a good corporate image. Such benefits create attraction for the organization. There is social recognition to organizations which provide educational, medical and other facilities to their employees and also to the people in the vicinity. People prefer to join organizations such as L&T, Tatas or Reliance due to liberal fringe benefits offered and good corporate image.

5. To raise employee morale: Liberal package of fringe raises the morale of employees. They form positive opinion about their organization. Fringe Benefits create efficient, stable, co-operative labour force for the benefit of the organizations.

6. To motivate employees: Fringes motivate employees to take more interest and initiative in the work. They are always co-operative and are willing to offer helping hand to the management as and when required. 8|Page

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TYPES OF FRINGES/FRINGE BENEFITS

1. Payment for the time not worked by the employees a) Holidays b) b)Vacation c) c)leave with pay and allowances

2. Contingent and deferred benefits: a) pension payment b) group life insurance c) group health insurance d) sick leave, maternity leave, child care leave e) suggestions/service award f) severance pay

3. Legally required payments: a) Old age, disability and health insurance b) Unemployment compensation c) Workers compensation 4. Miscellaneous benefits: a) Travel allowances/travel grants b) Company car and membership of clubs c) Moving expenses d) Child care facilities e) Tool expenses and meal allowances

EMPLOYEE SERVICES:

In addition to fringe benefits, many companies/organizations offer useful services to their employees called employee services. Such services are offered to the employees at no cost or at a nominal cost. However, the company has to spend money while providing such services. 9|Page

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Offering employee services is at the discretion of the managements. Such services make the employees satisfied and co-operative. Important employee services are noted below:

1) Eating facilities: Canteens, lunch rooms, subsidized food, company restaurants, cafeteria services and so on.

2) Transport facilities: Bus services, parking lots.

3) Housing facilities: Provision of staff quarters, loans for housing and subsidized housing.

4) Purchasing services: General store operated by the company, provision of companys products on discount basis.

5) Services relating to work performed: Subsidies for purchasing and up-keeping of clothing and uniforms, provision of tools, etc. required for work.

6) Child care facilities: Nurseries and day care centres.

7) Financial and legal services: Loans at lower rates, income tax services, legal aid and group insurance facility.

8) Educational services: Scholarships to children of employees, refund of tuition fees, educational leave and sponsorships for off duty training courses.

9) Medical services: Clinics and hospitals, counselling services, medical aid in case of serious diseases, accidents, etc.

10) Recreation and cultural services: Sports facilities, entertainment programmes, picnics, parties, library facility, social clubs, arranging lectures, etc

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FRINGE BENEFITS IN INDIA:

In India, fringe benefits include: (i) (ii) Statuary fringe benefits Voluntary fringe benefits

Statutory fringe benefits are compulsory and the employer has to give them to his employees. These benefits are generally social security and include gratuity and pension payments, the employers contribution to the employees provident fund and contribution to health insurance scheme (ESI). Voluntary fringe benefits include retirement benefit, medical care, compensation for injuries, subsidised food and housing, education and cultural facilities, maintenance of canteens and assistance of co-operative societies of employees.

Tata, Reliance, Bajaj and Mafatlal are some business houses which provide liberal fringe benefits to their employees. Companies like L&T, Cadbury India, DCM and TISCO are some companies which provide liberal fringe benefits to their employees. The same is the position of many software/IT companies. However, fringe benefits available to Indian workers are limited and inadequate as compared to working class in the west. Gratuities, pension payment, P.F., are some statutory benefits available to large majority of Indian employees. Voluntary benefits such as retirement benefits such as retirement benefit, medical care, subsidised housing and provision of educational and cultural facilities, etc. are also provided by many organisations in India. Sometimes such benefits are offered die to pressures from the trade unions.

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CHAPTER 4

EMPLOYEE STOCK OPTIONS AND PLANS

An employee stock option (ESO) is commonly viewed as a complex call option on the common stock of a company, granted by the company to an employee as part of the employee's remuneration package. Regulators and economists have since specified that "employee stock options" is a label that refers to compensation contracts between an employer and an employee that carries some characteristics of financial options but are not in and of themselves options (that is they are "compensation contracts"). As per SEBI, employee stock option means the option given to the whole-time Directors, Officers or employees of a company which gives such Directors, Officers or employees, the benefit or right to purchase or subscribe at a future date, the securities offered by the company at a predetermined price."

An ESO is a stock option granted to specified employees of a company. ESOs carry the right, but not the obligation, to buy a certain amount of shares in the company at a predetermined price. An employee stock option is slightly different from a regular exchange-traded option because it is not generally traded on an exchange, and there is no put component. Furthermore, employees typically must wait a specified vesting period before being allowed to exercise the option.

The idea behind stock options is to align incentives between the employees and shareholders of a company. Shareholders want to see the stock appreciate, so rewarding employees when the stock goes up ensures, in theory that everyone is striving for the same goals. Critics point out, however, that there is a big difference between an option and the ownership of the underlying stock. If the stock goes down, the holder of an option would lose the opportunity for a bonus, but wouldn't feel the same pain as the owner of the stock. This is especially true with employee stock options because they are often granted without any cash outlay from the employee.

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In 1992, only one million employees held stock options, mostly managers and executives. By mid-1990s, ESOPs have been growing steadily over the decade to 10 million. Infosys, HLL, WIPRO, Polaris, Dr Reddy, Ranbaxy, Wockhardt, Lupin, Gillette have introduced this.

An Employee Stock Option Plan (ESOP) is a benefit plan for employees which makes them owners of stocks in the company. ESOPs have several features which make them unique compared to other employee benefit plans. Most companies, both at home and abroad, are utilising this scheme as an essential tool to reward and retain their employees. Currently, this form of restructuring is most prevalent in IT companies where manpower is the main asset.

Abroad, ESOP (where the 'O' often stands for ownership) is seen when employees buy over the stock of an owner or promoter who is relinquishing charge. In India, ESOP is used largely to motivate employees to put in their best and in turn, help the company enjoy lower employee turnover and retain its talent pool. These two uses probably account for over twothirds of all ESOPs now in existence, and their numbers are expected to increase with time.

Interestingly, many companies abroad use ESOPs as a technique of corporate finance for a variety of purposes -- to finance expansion, to make an acquisition, to spin off a division, to take a company private, and so on. This has yet to catch on in India, perhaps because the scale of ESOP so far is too small for many of these uses. So far as the future of ESOPs in India concerned, as more and more companies realise the need to retain their best talent in a world which would be dominated by companies with the best intellectual capital, this management technique would be the phenomenon of the new century. Attracting, Rewarding and Motivating a talented employee is the main purpose of Employee Stock Option Plan (ESOP). In order to retain the human capital, companies in India are investing a lot of money these days. One such medium is to motivate the employee with the help of ESOP. Under this scheme, an alternative is given to the employee to acquire shares of the company. These shares are known as stock options and are granted by the employer based on the

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performance of the employee. Companies offer shares as an employee benefit and as a deferred compensation. As per the guidelines of SEBI, an employee should be a permanent employee residing in India or outside India. It also includes the director of the company; he can or cannot be a whole time director. The basic idea to give employee stock options in early days was to save cash compensations. It was a way to motivate the employee and even to save cash reimbursements for some of the cash strapped companies. These plans are over and above the salary of the employee but not in monetary form directly. Later, the concept of motivation picked up and retention led to spread of ESOP across company verticals. Most frequently, the ESOP is formed to provide an opportunity for the owners of a closely held, private, successful company to obtain liquidity for a portion of the shares that they own in the firm. The shares are priced conservatively based on the cash flow of the business, so it is a low valuation of the actual value of the firm. This makes the ESOP a gift from the shareholders to their employees which is why the media often announce ESOPS by saying that the employer gave the company to its employees. A second reason why owners establish ESOPs is that it motivates and rewards company employees for their contributions to the past and continued growth and success of the business. In some cases, the ESOP allows the company to borrow money to purchase property or other assets using pre-tax dollars, too. When you consider an ESOP from the point of view of the company owners, you must recognize that the company will be valued at a higher selling price by almost any other method of determining value. For example, selling the company would bring shareholders, in many instances, whatever the market will bear. This means that a successful company, sold to the highest bidder, could bring the owners 10, 20 or more times the valuation that is given for an ESOP. This approach would cause disruption for the employees when the purchasing company or individual decided to move the business, merge the company with another business, layoff 14 | P a g e

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redundant employees, and so forth. The ESOP provides the most stability for employees as long as the company remains successful. Most significant for employees, they receive shares in the ESOP without paying for them. When employees leave the company, or decide to retire, they receive their stock. The company is then required, in turn, to buy back the stock from the employee at fair market value. If the company has gone public, the stock price determines the value. The company has up to five years within which to make this purchase. As per SEBI Guidelines, the following are eligible for ESOPs:

An employee shall be eligible to participate in ESOS of the company. o A permanent employee of the company working in India or out of India; or o A director of the company, whether a whole time director or not; or o An employee as defined in sub-clauses (a) or (b) of a subsidiary, in India or out of India, or of a holding company of the company.

An employee who is a promoter or belongs to the promoter group shall not be eligible to participate in the ESOS.

A director who either by himself or through his relative or through any body corporate, directly or indirectly holds more than 10% of the outstanding equity shares of the company shall not be eligible to participate in the ESOS.

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WHY ESOPS:
Many companies use employee stock options plans to retain and attract employees, the objective being to give employees an incentive to behave in ways that will boost the company's stock price. If the company's stock market price rises above the call price, the employee could exercise the option, pay the exercise price and would be issued with ordinary shares in the company. The employee would experience a direct financial benefit of the difference between the market and the exercise prices. If the market price falls below the stock exercise price at the time near expiration, the employee is not obligated to exercise the option, in which case the option will lapse. Restrictions on the option, such as vesting and non-transferring, attempt to align the holder's interest with those of the business shareholders.

Another substantial reason that companies issue employee stock options as compensation is to preserve and generate cash flow. The cash flow comes when the company issues new shares and receives the exercise price and receives a tax deduction equal to the "intrinsic value" of the ESOs when exercised.

Employee stock options are mostly offered to management as part of their executive compensation package. They may also be offered to non-executive level staff, especially by businesses that are not yet profitable, insofar as they may have few other means of compensation. Alternatively, employee-type stock options can be offered to non-employees: suppliers, consultants, lawyers and promoters for services rendered. Employee stock options are similar to exchange traded call options issued by a company with respect to its own stock.

At any time before exercise, employee stock options can be said to have two components: "time value" and "intrinsic value". Any remaining "time value" component is forfeited back to the company when early exercises are made. Most top executives hold their ESOs until near expiration, thereby minimizing the penalties of early exercise.

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DIFFERENT TYPES OF ESOPS
ESOP can be a one-time plan or an ongoing scheme depending upon the objectives that the company wants to achieve. ESOPs can be in the form of ESOS (Employee Stock Option Schemes), ESPP (Employee Stock Purchase Plans), Compensation Plans, Incentive Plans, SAR/Phantom ESOPs etc. Employee Stock Option Scheme (ESOS) Under this scheme, the company grants an option to its employees to acquire shares at a future date at a pre-determined price. Eligible employees are free to acquire shares on vesting within the exercise period. Employees are free to dispose of the shares subject to lock-inperiod if any. Generally exercise price is lower than the prevalent market price.

Employee Stock Purchase Plan (ESPP) This is generally used in listed companies, wherein the employees are given the right to acquire shares of the company immediately, not at a future date as in ESOS, at a price lower than the prevailing market price. Shares issued by listed companies under ESPP will be subject to lock-in-period, as a result, the employee cannot sell the shares and/or the employee has to continue with the employer for a certain number of years.

Share Appreciation Rights (SAR)/ Phantom Shares Under this scheme, no shares are offered or allotted to the employee. The employee is given the appreciation in the value of shares between two specified dates as an incentive or performance bonus, that is linked to the performance of the company as a whole, as reflected in its share value.

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HOW ESOPS BENEFIT THE EMPLOYEE AND THE COMPANY
Making employees a stakeholder in the company's growth is not easy. One way companies do this is Employee Stock Options or ESOPs , which give employees the option to buy a certain number of shares of the company at a pre-decided price.

Though information technology (IT) firms started the trend, companies in many sectors such as banking, financial services, manufacturing, consumer goods and capital goods are now giving ESOPs to employees.

Attract and Keep Talented Employees: Most companies are painfully aware of the difficulty in attracting talented staff. Just as successful sports teams must grow; their own talent or attract experienced players from other teams, employers must follow the same path. Top recruiting firms, like Kelly Services and others, and extensive company sponsored searches seek the best available talent, even during down economies. Offering meaningful stock options both attracts better, more talented employees and helps keep them for the long term.

Create More Dedicated Employees Employers are constantly attempting to motivate employees and generate loyalty. Volumes have been written about the subject, and numerous experts; and consultants abound with a wide variety of theories, suggestions and programs. Stock options are a valuable benefit that companies use to create higher level motivation and dedication. It typically works very well, As employees exercise stock options, they usually become more committed to a company & its success. Their stock value hinges on company performance, which, of course, is a direct by-product of employee achievement. Historically, stock options create motivation and dedication for all employees involved as they are more invested in the company and its results.

Cost Effective Company Benefit As the cost of all employee benefits continues to increase, companies expand their search for programs that offer high value for moderate cost. Stock option plans often prove to be a

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strong benefit for employees and cost-effective for companies. While stock options are seldom substitutes for compensation increases, as part of a solid benefit program, they help make employment packages more attractive. The only significant costs to the company are the lost opportunities to sell some stock at market value (since employees usually buy at a discounted rate) and the expense of administering the plan. Added to the ability to attract, keep and motivate staff, the cost efficiency of stock options helps many smaller companies compete with larger organizations by offering comparable benefit programs.

Lock-in Period- Retention: ESOPs come with a lock-in period known as vesting period and employees can exercise the options only after this period. If the employee leaves the organisation before completing the specified period these ESOPs get lapsed and the employee will not get any benefit. A Sense of Ownership for the employees: When the employees are given shares of the same company in which they are working, it gives them a sense of feeling that now they are not employees of this organisation but are the owners. As they are now they owners, they also have a share in the profits of the company. In fact, since employees directly benefit from the increase in the share price, they focus on overall value creation for the company.

Kind instead of Cash ESOPs are a way of awarding the employees in kind instead of cash. In the initial days of ESOPs in India small organisations who were cash strapped used to give ESOPs to their employees to increase the overall pay package. In this manner, they were able to compensate the employees in kind without affecting their cash reserves if a organisation issues ESOPsits cash reserves are not affected).

Tax Benefits One of the most attractive benefits of an ESOP is that it can be used to cost-effectively finance growth through its tax-privileged status. An ESOP has the ability to borrow money to purchase shares of the company. Once the ESOP purchases the shares, the company has use of the borrowed funds. The tax savings are realized when the borrowed funds are repaid. 19 | P a g e

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Because ESOP contributions are tax deductible when the company makes contributions to the ESOP to repay the borrowed funds, the contributions, within certain limits, are tax deductible. As a result, the ultimate cost of borrowing to the company is significantly reduced and a cash flow advantage is gained.

An opportunity for liquidity: Over the past 35 years more than 40,000 U.S. company owners have taken advantage of this opportunity to create shareholder liquidity without having to sell the entire company. A particular advantage of selling to an ESOP is its flexibility. An ESOP can be used, for example, to buy a portion of the stock from all shareholders on a pro rata basis, or to buy out all of the stock of an inactive shareholder, a retiring shareholder or a minority shareholder. Although ESOPs are mostly designed for privately-held companies, many well-known public companies have adopted ESOPs and/or broad-based employee stock ownership plans as a way to reduce turnover and absenteeism and increase employee productivity and company profitability. Some of the Fortune 100 companies that have used this technique to their advantage include, Exxon Mobile, Procter & Gamble, Walgreens, Costco, Microsoft, United Parcel Service, Intel, Cisco Systems, Abbott Laboratories, Amazon, Google, and 3M. Many of this countrys largest privately-held companies have also used this to their advantage, including companies such as as Cargill, Publix, Fidelity Investments, S.C. Johnson & Sons, Bloomberg, Wawa, Hy-Vee, CH2ME Hill, WinCo Foods, Graybar Electric, Edward Jones, Hallmark Cards and Andersen Windows.

A Superior Employee Incentive Program An Employee Stock Ownership Plan is designed to provide employees with the incentive of a piece of the action, and to enable employees to share in the capital growth of the company. Employee stock ownership gives employees a direct and vested interest in the success of their company, enables employees to share in the profits of their own labor, and creates an identity of interest between management and labor.

As an employee incentive device, the ESOP is usually superior to other incentive plans. In an ordinary profit sharing plan, for example, the funds are invested in stocks of unrelated 20 | P a g e

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companies, and the incentive effects are minimal. In an ESOP, on the other hand, the employees acquire an ownership interest in their own company, and the incentive element is maximized. The ESOP is a flexible plan that can be used either in lieu of or in combination with other employee benefits plans. Because of its many advantages, the ESOP is becoming an increasingly popular form of employee benefit. The ESOP is particularly advantageous for companies whose rapid growth has required the reinvestment of profits, resulting in a shortage of cash available for employee benefits. A collateral benefit is that the ESOP often serves to diminish employee interest in unionization.

WHAT ARE THE DISADVANTAGES THAT ARE TO BE CONSIDERED:

Set up and Administration Cost: ESOPs are not cheap and the cost of both creating and maintaining an ESOP should be strongly considered. The evaluation and implementation of an ESOP is complex and requires multiple levels of tax, legal, actuarial, financial and administrative expertise. ESOPs typically cost at least $50,000 to set up, depending on the complexity and the size of the transaction. For larger companies, these fees can quickly add up to $500,000 or more. An ESOP is more expensive than other benefit plans but usually much cheaper than other ways to sell a business. Some of the fees involved in an ESOP include a financial feasibility study, legal fees for both the employees and the employer, investment banking fees to help find financing, bank charges, trustee charges and formal valuations of the company initially and on an annual basis. In addition, there are administration fees which typically range from $3,000 to $10,000 a year.

Volatile Markets and Fall in Employees Morale: If the value of the companys shares falls, then employees share the loss and morale may suffer. In addition, if the contribution is in the form of newly issued stock, then the ESOP dilutes the current stockholders ownership. 21 | P a g e

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Similarly, where the share price of the companys shares does not increase and the employee feels they have no control over the share price outcome, then it can affect morale and retention.

Company Value If the company value does not increase, the company stock is less attractive and employees may wish to invest their retirement funds somewhere else. In the worst case scenario, if the company fails, employees will lose their retirement funds that are invested in the company. Losses may be severe if the ESOP investment is not diversified

Cash flow issues: An ESOP can create serious cash-flow issues for a company. If a company borrows money to fund an ESOP, it will have to allocate significant future earnings towards repayment. For a company that is accustomed to a conservative debt-to-equity ratio, this can be a significant change. The company must also be prepared to buy back shares of retiring employees. If a company has a large percentage of employees nearing retirement age, there is a very real potential of a cash drain.

ESOPs are expensive to administer: ESOPs can be expensive to administer. As a tax-qualified retirement plan there are substantial federal regulations and reporting requirements that must be complied with. It has been estimated that start-up costs can run anywhere between 3% and 6% of the value of the initial plan. These costs, at least in the short-term, may outweigh any potential tax benefits. Additionally, legal and accounting expenses for yearly compliance and reporting requirements can run in the thousands of dollars. As part of the administrative expenses, Federal regulations require a valuation of ESOP shares by an independent third party on a regular basis.

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Dilution Of Ownership An ESOP dilutes the ownership stake of the original owners because additional stockholders are created.

Liquidity Problems An ESOP may create liquidity problems when stock value appreciates significantly. When employees retire, the company may not have sufficient cash reserves to repurchase the retiree's shares of stock at the time of retirement.

Reverse Effect An ESOP may actually lower employee motivation if company performance is poor and the value of company shares flat lines or decreases. Employees may turn to other sheltered retirement plans like an IRA or Roth IRA in which the employee controls where and how savings are invested.

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CHAPTER 5

COMPANIES IN INDIA WHO HAVE USED ESOPS

ESOPs were the harbinger of good times in the 1990s, when a large number of IT companies allotted them to employees and helped them take part in their growth, making many of them millionaires. Take the case of Infosys, the first Indian company to issue ESOPs. The company, started in 1981, is known to have given away Rs 50,000 crore worth of ESOPs to employees since inception. In the 1990s, it allotted ESOPs in three tranches, at Rs 50 a share. By 2000s, thousands of employees had become millionaires by encashing these when the stock was at Rs 7,000. The interest in ESOPs did not last long as the gains depended on the market prices of the shares. The dot.com bubble triggered a dramatic fall in IT stocks and ESOPs worth millions became dud. Infosys, too, discontinued the scheme in 2003-2004 citing lack of employee participation and difficulties in account reconciliation. "Despite this, ESOPs have never really lost sheen and continue to be preferred by companies and employees as a source of remuneration," says Harshu Ghate, co-Founder and CEO, ESOP Direct, which works in the field of equity compensation.

Many companies like Infosys in their early days used to award employees and even clerical staff with ESOPs. This way, there were able to manage their direct costs. Moreover, giving ESOPs to employees was also a way of motivating the employees to work harder by creating the sense of ownership and directly rewarding employees for their increase in the companys valuation. Infosys grew very fast; many employees who got ESOPs of Infosys in the early days and preferred to keep these shares have today turned millionaires. Infosys used to even award Drivers, Office Assistants and Secretaries with ESOPs and many of them have also turned millionaires.

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Many small companies which are growing fast but are in need of cash have started replicating the ESOPs model which was implemented by Infosys. This model not only helps the organisations preserve cash but also keeps the employees motivated. In fact, Narayan Murthy went on record saying that Every Indian employee at every level who joined the company on or before March 2010 is a stakeholder of Infosys. Infosys earlier used to award ESOPs to almost all its employees but has now started awarding ESOPs judicially as awarding too many ESOPs may dilute the promoters & investors stake.

BPO pioneer Raman Roy was setting up Spectramind in 2000-2001, its human resources head S. Varadarajan offered share ownership to 500 staff members. We wanted to share wealth with people who helped create the company, Varadarajan says. When Wipro bought out Spectramind, everyone made the equivalent of at least a years salary on their ESOP plans. Even better, turnover among the top managers was zero. Now, at Quattro BPO Solutions, another start-up from Roy, Varadarajan heads human resources and is replicating the ESOP experiment, covering employees from the supervisor level.

Believers like Varadarajan are growing but the pool of companies using ESOPs in India remains limited. The wealth creation potential of ESOPs has not been fully exploited in India. The trend is yet to catch on with a large number of firms. There are many who are sceptical. During the best of times, amid war for talent, nothing could guarantee stickiness of executives, not even ESOPs. There was always somebody who was willing to better the deal offer a bigger package and lure away executives, says Prabir Jha, HR head, Dr. Reddys Labs. The Indian ESOP is unique in how it is implemented. Its used as a carrot, dangled in front of employees so they dont quit. Its a long-term incentive but employees dont seem to get the point. ESOPs are not considered part of compensation in many Indian organizations and are not communicated as such says Padmaja Alaganandan, India business leader (human capital), Mercer Consulting. This is unlike in the West, where it forms a substantial chunk of a senior executives total 25 | P a g e

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compensation. In the US, ESOPs are used to push productivity, link reward to performance and align the interests of the shareholders and executives. In India, where ESOP adoption is still in its early stage, companies use stock options to attract and retain employees.

And ESOPs appeal depends on the stock market. Until 2007, when the going was good, ESOPs were a very attractive incentive to lure potential employees. Globally, start-ups have used ESOPs to recruit key executives, reward and share the risk with them.

Bajaj Electricals, for instance, hired staff from other sectors for as little as a 10 percent jump in salary (when 50-100 percent increases were normal), by using attractive ESOP offers, says executive director R. Ramakrishnan. Private banks like Axis Bank, with no global tag and not-so-deep pockets, used ESOPs to compete for talent against multinational giants. From unlisted, family-managed entities like Murugappa group to old-fashioned manufacturing firms like Larsen & Toubro, companies have used them to gain shine in the job market. Then, the slowdown hit and Indian entrepreneurs were hit hard. Earlier, Indias hot job market and economic boom meant ESOPs got marketed as the biggest and quickest way to riches. This mis-selling made everyone look only at the upside and forget the downsides. Excitement around ESOPs has waned. Unpredictable stock market has taken the sheen off, says Sanjiv Sachar, speaking about the immediate aftermath. He is partner, Egon Zehnder International, a leading executive search firm. Compensation experts say Indias demography too has had an impact. Across the hierarchy of positions, people are spending less time with one job. Everyone prefers more cash in hand than something thats long-term and uncertain, says Shekhar Purohit, Asia-Pacific head compensation & corporate governance, Hewitt Associates.

Now that economic recovery has begun, experts believe corporate India will see a mature ESOP. Those who do vouch for ESOPs say there is no one formula that fits everyone at all times. An ESOP plan must be fine-tuned in sync with a companys growth cycles to be effective. 26 | P a g e

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Telecom major Bharti group began its ESOP journey in 2001. In its pre-IPO stage, it covered the top 100-125 executives. In 2005, it launched the second stage where everybody was covered and ESOPs were linked to the employees loyalty and performance.

On a sharp growth trajectory at that time, Bharti wanted to reward and incentivise its staff. In 2006, it offered performance share plan to senior executives pegging the allotment to different kinds of performance individual, stock price and competition. By 2008, it figured that its 2005 wide-base ESOP strategy wasnt working as the younger staff preferred deferred bonus plan or cash. Hence, now the company has restricted the plan to the middle management and above. ESOPs work when a company constantly does course correction and customisation to be more current and better aligned, says Inder Walia, group director for HR at Bharti Enterprises.

Among the top firms, premier private sector lender HDFC Bank has allotted 2.55 crore shares worth over Rs 1,680 crore to employees and FMCG major ITC has allotted 3.78 crore shares (Rs 1,104.89 crore) to their respective employees.

Among those leading the pack, housing finance giant HDFC has also given 1.14 crore shares (Rs 916.67 crore) and engineering and infrastructure conglomerate L&T has allotted 29.87 lakh shares (Rs 428.50 crore), data compiled from stock exchange filings show.

Most of the listed companies have Employee Stock Option Plans under which employees receive the right to purchase a certain number of shares in the company at a pre-determined price. This is given as a reward for their performance and also acts as a motivation tool for employees.

Employees typically have to wait for a certain duration known as vesting period before they can exercise the right to purchase the shares.

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Wipro with 39.83 lakh shares (Rs 165.52 crore) and Ambuja Cement with 71.29 lakh shares (Rs 135.46 crore) are also among the firms that allotted scrips worth at least Rs 100 crore at current prices in this fiscal year.

Major companies which allotted shares worth at least Rs 10 crore to employees in 2012-13 financial year include ICICI Bank (Rs 73.85 crore), Lupin (Rs 51.22 crore), Dr Reddys Lab (Rs 49.76 crore), IDFC (Rs 36.90 crore), Hindustan Unilever (Rs 25.44 crore), Ranbaxy (Rs 22.05 crore), UltraTech (Rs 20.21 crore) and Grasim (Rs 14.31 crore), data shows.

Now is the time to build the foundation for the next wave of ESOP adoption in the country. Here are five major trends that may shape the future of ESOPs in India:

New Products, New Segments From a plain vanilla ESOP plan, companies are now willing to experiment with variants of ESOPs to suit their needs better. These range from phantom options to restricted stock units (RSUs), stock appreciation rights (SARs) to performance share plans. Companies like Wipro are looking at alternative means like deep-discounted restricted stock units to make options attractive. L&T offered SARs to avoid equity dilution and yet offer its staff the upsides of the stock movement. Companies like Infosys are going one step ahead, giving ESOPs to independent directors and driving board level involvement.

Pushing Performance In a difficult business environment where pushing employee productivity is the key to survival, companies are pegging their stock option plans to corporate and individual performance. To calculate eligibility, they are moving away from the volatile measures of the stock market and going for more predictable pointers such as business orders, profit margin, relative performance in an industry and customer satisfaction. Some sanity is returning to compensation planning too. Purohit of Hewitt Associates sees a dip in heavily used deep discounted ESOPs. Cash-starved firms are looking at supplementing salaries with options. 28 | P a g e

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New Vistas for ESOPs The recommendation of the 2nd Pay Revision Committee set up by the Department of Public Enterprises which looked at the compensation structure for the PSU staff, will have a significant impact. One of the major recommendations is the mandatory portion of Performance Related Pay (PRP) for every PSU employee and interestingly it is mandated that at least 10 to 25 percent of the PRP should be in the form of ESOPs. Many PSUs, especially those who face competition for talent from the private sector insurance, oil and gas, telecom, etc. wanted to implement ESOPs but were unable to do so in the absence of clear guidelines and government nod. With these recommendations in force, they are soon expected to roll out Equity Options to their employees. Another development is the recommendation in the last Budget for the companies to have a minimum of 25 percent public holding as a pre-requisite to maintain their listing status. If the company were to approach the public every year with a 5 percent offer, its not only a laborious process but also costly. ESOPs provide an ideal solution. Employee holding is considered as public holding and implementing ESOPs is not costly and not time consuming (no approvals apart from Shareholders approval is required). ESOPs also help achieve multiple objectives such as wealth sharing with employees, and broad-based employee ownership helps synchronize interest of employees and shareholders. This will help in minimising the negative impact on share price, preferential allotment could come with some other constraints such as board representation, restriction on promoter share transfers, and other operational covenants. ESOPs would have no such constraints or impact on the company management and operations.

Transparency and Communication For many in India, ESOPs werent clearly thought out and transparent. Not many had robust performance management system. Loyalty and favouritism played a critical role in shaping ESOP plans. Especially in promoter-driven companies, decisions were quite subjective. Worse, some oversold their ESOP plans highlighting only the expected upsides. Through the years of hyper growth, there did not seem to be any reason to warn against the downside, 29 | P a g e

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says Mercers Alaganandan. This led to a lot of heartburn when the value of ESOPs evaporated in the markets. Clearly, stating out the objectives and scheme parameters will hold the key, says Mayura Arankalle, manager consulting, ESOP Direct.

Unlisted Opportunity Its the unlisted companies that provide the biggest upsides and can benefit the most with ESOP as a tool. While they have been offering aggressive ESOP plans to woo talent, they are also getting savvier and smarter in using them. They are adopting the boutique approach to customise ESOPs. To take one example, some firms are offering different classes of shares with different voting rights. Responsible behaviour during uncertain times is boosting confidence as well. ICICIs insurance JV, which offered ESOPs to its staff with an eye on exit during the IPO, repurchased the shares six-eight months ago. Since the IPO got postponed due to poor market conditions, this was the companys way of offering an exit to the employee shareholders. Regulatory norms too have helped. Since 2007, all unlisted companies in India have to get an annual valuation certificate. For the moment, any conversation around ESOPs draws disinterest and impatience from employers and employees alike. It is understandable because many have burnt their fingers and seen their millionaire dreams crash.

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CHAPTER 6

ESOPS AS A TOOL FOR HRM:

ESOPS AS A TOOL FOR EMPLOYEE MOTIVATION & RETENTION


One of the main reason companies state for issuing stock options is to motivate employees. When employees have a stake in the company they are motivated to put in extra effort for the growth of the company. Making employees a stakeholder in the company's growth is not easy. One way companies do this is Employee Stock Options or ESOPs, which give employees the option to buy a certain number of shares of the company at a pre-decided price. Though information technology (IT) firms started the trend, companies in many sectors such as banking, financial services, manufacturing, consumer goods and capital goods are now giving ESOPs to employees. For decades now, American firms have engaged in a capitalist experiment, helping their employees to become partial owners of their companies in the expectation that this will encourage them to work harder. Currently, more than one-fifth of U.S. private-sector employees -- 24 million workers -- own stock in their own companies; eight million participate in Employee Stock Ownership Plans (ESOPs). The growth of ESOPs over the past 25 years is part of a general trend in compensation arrangements linking worker pay to company performance. These techniques include profit sharing, gain-sharing, and broad-based stock options in addition to the various methods of employee ownership. Some research shows that firms with employee ownership tend on average to match or exceed the performance of other similar firms. There may be an average 4 to 5 percent gain in productivity with introduction of an ESOP, but with a wide band of outcomes around that average. Several studies find higher satisfaction, commitment, and motivation among employee-owners. Other studies find no significant differences in these factors between worker owners and non-owners, or before and after an employee buyout of a firm. 31 | P a g e

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For example, employee ownership of United Airlines failed to prevent its bankruptcy, while multiple forms of employee ownership and profit sharing at Science Applications International Corp., a Fortune 500 company engaged in research and engineering, have led to its continued success. In this period of recession, when the profit graph is falling down and cash flow is one of the challenges for the companies, the biggest test for an employer is to retain star performers without shredding cash from the pocket. As talent management leaders are inventing new ways to face this challenge, we re-walk you through the age-old carrot 'stock options' as a tool for talent retention. Many companies use stock option plan as an effective tool not only for retention but also to compensate the existing employees and to attract new talent from the market. Stock option plan is a contract between the employer and the employee which gives the employee a right to purchase company's shares at some time in the future at a discounted price. Employees are eligible to exercise their right to buy shares, after the options are vested. Ideally, the market value of the shares would increase during the vesting period, so that employees are able to purchase shares at a significant discount. Upon exercise of options, the employees can either hold the shares or sell them in the market or back to the company/promoters if the shares are not listed. The effectiveness of stock options in increasing employee loyalty and commitment to the company cannot be ignored. However, we still avoid using them in our businesses. Their high administrative cost and the fear of dilution of your equity is what perhaps overshadow the benefits they offer. But isn't it cost effective to administer a plan rather paying the cash upfront? Whether administrative cost of the plan surpasses the benefit of retention of the employees? Is there a way to share the growth of the company with employees without diluting your equity under a stock option plan? While, the commonly used techniques of remunerating employees have to be funded by significant cash outflows, the first reason why stock options find favour over all of these techniques is the fact that grant of stock options does not require cash outflow for the employer. 32 | P a g e

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Secondly, stock options are a long-term form of remuneration, as the vesting schedule ensures that the employees work for a specific length of time before they encash the options. Besides this, the vesting schedule can be re-engineered keeping the company's objectives in mind. Most companies have schemes wherein options vest annually over a few years, say about three to four years. Another innovative mechanism may be an annual grant of stock options with overlapping vesting periods. With every new grant of options, the employee's stake magnifies, thus ensuring his longevity in the company. Next, the vesting conditions inbuilt in the stock option schemes can help the company align employee's performance with its own objectives. Vesting conditions could include a target turnover, market performance of the share, or any other condition that the company finds reasonable as well as attractive. Thus, stock options satisfy the twin objectives of employee retention along with improved company performance. Companies can smartly work around with the variety of stock-based incentive plans available nowadays without allotting actual shares to the employees. Eg. Stock appreciation rights give employees, the monetary equivalent of increase in share price over a specified time. Cash settled stock based plans ensure that the employee grows with the growth of the company and at the same time promoter is not required to worry about dilution. What may concern some employers is the uncertainty about the regulations and compliance surrounding the issue of stock options. It may be interesting to note that though stock option schemes of listed companies need to be compliant with the Securities and Exchange Board of India (Employee Stock Option Scheme and Employee Stock Purchase Scheme) Guidelines, 1999, stock options issued by unlisted companies or under a global stock option plan are not required to observe any such compliance. There are no social taxes / provident fund regulation applicable in India on allotment of stock options. However, employer is required to deduct tax at source under Income-tax laws at the time of allotment of shares to the employees. Success of a stock option plan depends on the effective employee communication. It finds favour with employees only if the scheme is explained well to them. Hence, it is very important to convey the features which make stock options advantageous for the employees such as:

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The stock option plan is a legal contract between the employee and the employer which protects employee's right to receive benefit in future. It gives an employee a right but not an obligation to participate in the plan but the employer is bound to pass the benefit as per the terms of the plan.

A recent example of employee stock option being used as a retention tool is that of the social media giant, Twitter. Twitter reportedly began handing out stock option grants to valued employees over the past two weeks, a manoeuvre likely designed to keep the social media companys vested employees on the hook for a longer tenure. According to a report in AllThingsD.com, Twitter began handing out stock grants to not only executives but also valued individual contributors in recent weeks. With Twitters IPO documents officially filed with the Securities and Exchange Commission, employees who have been with the seven-year-old company for more than four years are the most likely risks to bolt after the company goes public and its lock-up period expires, say recruiters. Stock options typically vest in increments over a four-year period.

Most options vest 25 percent after a year [at the company] and then monthly or quarterly thereafter, with full vesting at four years. So, an employee who has been with a company four years at the time of the IPO is fully vested and thus leaves a lot of money on the table if he or she leaves [before the IPO]

But if a new employee had been at Twitter for six months prior to the IPO, then none of his or her options are likely to have vested. As a result, that employee would need to stay with the company at least a year before a quarter of their options would vest, for example. Hence, the term golden handcuffs.

And to keep employees who are already fully vested by the time the IPO goes out, Twitter would have to issue more stock options, which would then carry another four-year vesting schedule from the time of issuance.

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CHAPTER 7

ESOPS AS A STRATEGIC TOOL

ESOPS AS A KEY TO SUCCESS In most well-managed companies the last significant opportunity for increasing profitability lies in enhancing employee productivity. This employee productivity is in the internal discretion of the company, as compared to the other components of the profit equation. Employee productivity is predominantly linked to sense of ownership being instilled in the employees. Ownership by employees is the only successful system for big business. A man has to have more interest than his salary to produce the best that is in him. The goal of employee ownership is to align the self-interest of all stakeholders in the business so that everyone shares the same motivation to achieve higher profits. The same is true today. there is no greater productivity bang for your buck than the adoption of a well-conceived and consistently executed employee stock ownership program. A study performed by the National Center for Employee Ownership indicates that, after controlling for industry-wide variables, employee-owned companies grew 5.4% faster than comparable non-employee owned companies. Over a decade, this differential would result in the ESOP companies having sales 70% higher than their non-employee owned competitors. When ESOP companies encouraged employee participation, their growth rates were 8-10% better comparable as compared to non ESOP offering companies. Here are some proven examples of success: o Inc. magazine awards its Entrepreneur of the Year award to all 240 owner-employees of the Connecticut firm Reflexite, Inc. Out of 2,700 private companies evaluated, 4 of the 5 finalists had substantial employee ownership.

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o Improving Productivity Earns Dalton Foundries Senate AwardThe Warsaw, Indiana foundry was presented the United States Senates highest honor, its Productivity Award...[Employees] bet their jobs and retirements on the ESOP and knew they had a lot to lose if the buyout failed. Modern Casting.

o The National Center for Employee Ownership contrasted private companies before and after installing an Employee Stock Ownership Plan: 73% significantly improved their performance. Harvard Business Review Over 11,000 of Americas most successful companies are currently using Employee Stock Ownership Plans to increase productivity and profitability, to grow the company, and to cash out shareholders tax-free.

The ideal productivity enhancement technique would thus have the capacity to boost both capital investment and employee motivation. An Employee Stock Ownership Plan is just such a technique. Designated by statute as a tool of corporate finance, an ESOP establishes an incentive system that is rooted in ownership while simultaneously assisting the employer company with capital formation or conservation.

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ESOPS AID SURVIVAL

Over 97% of the Americas ESOPs are in successful private companies. While press accounts naturally focus on exciting stories of companies trying to use employee ownership as a tool to stave off failure, such dramatic rescues are rare. Nevertheless, they do occur. For example, Oregon Steel Company went from near bankruptcy in the early 80s to making millionaires out of many of its employee-owners. According to the Wall Street Journal, its productivity rate after a 100% employee buyout climbed to double the industry average.5 Even the unflappable editors of the National Enquirer were impressed: Company gave them worthless stock years agonow its worth a fortune. If a well-conceived employee ownership program is introduced during a period of reduced profitability, the employees have a strong incentive to salvage the company before it needs to be sold or liquidated. As a turnaround tool, employee ownership can help retain experienced, productive employees at a time when the company cannot provide increased cash compensation. By funding the ESOP with convertible preferred stock, the company guarantees the employees some current return and preference if the company is forced into liquidation. After the company returns to profitability, the employees who helped it survive the tough times will own a pre established percentage of the common shares upon conversion of their original preferred stock.

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CHAPTER 8

CONCLUSION

An ESOP can be an effective tool to transition a retiring business owner, achieve taxadvantaged growth and build employee morale. However, as a tax-qualified employee benefit program, an ESOP comes with significant legal obligations. When considering an ESOP, a company would be prudent to consult with an experienced attorney and accountant/business consultant for an informed opinion as to whether the potential benefits outweigh the drawbacks to the company.

National studies reveal that on average, ESOP companies tend to be at least 8% to 11% more profitable than their non-ESOP counterparts. Highly motivated employees owning a part of the company generate increased profits. The employees are encouraged to take a more active interest in company performance because they share in the equity growth created through productivity increases. In addition, a company can increase profits by paying significantly less corporate income tax than they would have without the ESOP through deductible contributions to the Plan. This reduction in corporate income tax will help increase the cash flow and net worth of the company.

While there are significant advantages to implementing an ESOP, there are also a few disadvantages that must be considered. If the value of the companys shares falls, then employees share the loss and morale may suffer. In addition, if the contribution is in the form of newly issued stock, then the ESOP dilutes the current stockholders ownership. The first step in determining if the advantages of an ESOP outweigh the disadvantages is to complete a feasibility study to help determine if an ESOP is a good choice for the company.

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CHAPTER 9

BIBLIOGRAPHY

The project has been aided by references from the following:

1. Google Search Engine 2. Wikipedia 3. The National Centre For Employee Ownership 4. Investopedia 5. Securities And Exchange Board Of India 6. The Economic Times 7. NDTV Profit

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